Services sector optimism and profitability falls

Optimism across the services sector fell sharply in the three months to November, as business volumes and profitability both declined, according to the latest quarterly CBI Services Sector Survey.

Sentiment declined in both sub-sectors. In the business and professional services sector – which includes accountancy, legal and marketing firms – optimism about the business situation fell at the fastest pace since November 2016. Sentiment in the consumer services sector – which includes hotels, bars, restaurants, travel and leisure firms – also fell again, after improving in the quarter to August.

Trends in business volumes deteriorated in both sub-sectors. The business and professional services sector saw growth in business volumes stall, following a steady expansion earlier in 2018, with a slight decline expected in the three months to February. Meanwhile, consumer services firms reported a steep drop in business volumes and also expect a further fall next quarter.

Against this backdrop, business & professional services firms reported that profitability was unchanged for a second successive quarter, while consumer services reported the steepest drop in profitability in a year. Profitability is expected to decline in both sub-sectors over the quarter to February.

Cost pressures eased slightly in both sub-sectors but remained above average. Selling prices increased at a steady pace in business and professional services, but price inflation slowed in consumer services. Price inflation is expected to pick up moderately in both sub-sectors next quarter.

Overall economic growth is expected to remain subdued, reflecting weak household income growth and the drag on investment from Brexit uncertainty. For more detail, see our June economic forecast.

Rain Newton-Smith, CBI Chief Economist, said:

“Brexit uncertainty continues to take its toll on the UK’s services firms. Volumes and profitability are under pressure, and optimism about the business situation is falling across the sector.

“Services firms expect to be operating in a challenging environment over the next quarter and beyond, with demand set to weaken in the coming three months and firms seeing little prospect of expanding their businesses in the year ahead.

“The first step to remedy this situation is for Parliament to pass the Brexit deal agreed between the UK and the EU. Whilst the deal is not perfect, it has two essential benefits for our economy. First, and most crucially, transition pulls the country back from the extremely damaging “no deal” cliff-edge that would harm jobs and living standards. Second, the agreement opens a route to a long-term trade deal, which must have ambitious access to the European marketplace for our world-beating services sector.”

Investment intentions for the year ahead are subdued in both sub-sectors, but more starkly so for consumer services. Expenditure on land and buildings is expected to be cut back at the fastest pace since August 2013, and spending on vehicles, plant and machinery cut at the fastest pace since August 2012. In both sub-sectors spending on IT is expected to continue growing in the year ahead, however.

Employment growth remained firm in consumer services and around the average in business and professional services, with growth in headcount in both sub-sectors expected to edge higher in the coming quarter. But concerns about the availability of both skilled and unskilled labour remain elevated in both sectors.

Key findings

Business and professional services:

Optimism regarding the general business situation fell (-18%) at the fastest pace for two years (-19% in November 2016) in the quarter to November

Growth in business volumes stalled (-2%, down from +14% in August). Growth is expected to weaken further in the three months to February (-5%)

Profits were also flat (-3%) and are expected to decline a little over the next quarter (-7%)

Growth in total costs per person eased somewhat (+32% from +45% in August), but remained above average (+27%). Cost growth is expected to be broadly steady next quarter (+29%)

Growth in average selling prices was broadly stable (+7%, down from +9% in August), but selling price inflation is expected to be pick up marginally in the three months to February (+13%)

Numbers employed (+12%) grew at a steady pace, and are expected to rise further next quarter (+17%)

Investment intentions are relatively subdued – firms expect to keep spending broadly unchanged on land and buildings in the year ahead (+1%) and on investment in vehicles, plant and machinery (-4%). Meanwhile, investment on IT is expected to increase (+20%) at an average pace

A small majority of firms expected to expand their business in the year ahead (a net balance of +4%, up from +1% in August).

Consumer services:

Optimism about the general business situation deteriorated in the quarter to November (-7%, from +7% in August).

Business volumes fell (-13%), following a modest increase in the previous quarter (+7%). A further fall is expected in the three months to February (-7%)

Profitability fell for the third consecutive quarter (-23%), and is expected to fall again next quarter (-27%)

Growth in total costs per person eased (+40%, down from +51% in August) but remained above the long-run average (+37%). Cost growth is expected to pick up in the three months to February (+59%).

Average selling price growth eased (+6%) from the previous quarter (+20%), to a level below the long-run average (+14%). Selling price inflation is expected to pick up next quarter (+16%).

Employment expanded at a steady pace (+21%), and solid growth in headcount is expected next quarter (+33%).

Investment in IT is set to increase in the year ahead (+27%). However, firms expect to cut back on spending on land and buildings (-10%) – the lowest since August 2013 (-24%) – and on vehicles, plant and machinery (-20%) – the lowest since August 2012 (-32%)

A minority of firms said they expected to expand their business in the year ahead (-19%, down from +5% in August).